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$1 Trillion Budget Deficit by 2017?

The Congressional Budget Office released new figures on the federal budget yesterday, which show that the deficit will peak in 2009 at $438 billion and decline thereafter. But budget watchers and CBO economists know that these “baseline” projections don’t describe actual budget realities.

So I constructed a “business as usual” scenario for revenues and spending to get a sense of the fiscal picture that the next president will actually face. The figure illustrates that it will be much easier being the president who enters office in 2009 than the one who enters office in 2013.

The revenue line in the figure assumes that all current tax cuts are extended and the alternative minimum tax is indexed for inflation. Extended tax cuts include income tax rates, dividends, capital gains, child credit, death tax, expiring business breaks, and other items.

The spending line assumes that discretionary spending rises as fast as GDP, the number of troops in Iraq and Afganistan is reduced to 30,000 by 2011, and Medicare payments to physicians are not cut back after 2010 as under the baseline. These adjustments are based on CBO data. I also estimate the extra federal interest costs of these assumptions.

The results indicate that the federal deficit would be held roughly constant as a share of GDP until 2012, mainly because of the optimistic draw-down of troops abroad. But after 2012, spending explodes as entitlement programs continue a long-term expansion under a no-reform scenario.

Federal revenues will remain roughly constant at a bit less than the long-term average of about 18 percent of GDP. Revenues dip in the first few years as corporate tax revenues fall, but then commence a slow and steady rise as real bracket creep pushes people into higher income tax brackets.

In the chart, the revenue line is quite flat, but the spending line begins a rapid ascent after 2012, making it clear that the federal fiscal problem is caused by overspending, not a shortage of tax revenues.

Under the scenario shown in the figure, the federal budget deficit will hit $1 trillion in 2017 and $1.1 trillion in 2018, which will represent 5 percent of GDP that year. The president coming into office in 2013 will be forced to take major actions to stem the tide of red ink.

The open question is whether the president extering office in 2009 will muddle his way through without spending reforms–as he could probably get away with–or whether he carves a new path and finally tackles the out-of-control spending machine in Washington.